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24 May 2012

Selling a privately-owned business: how can you fix the common problems before a buyer appears?

by Nick Miller

Practical steps to sort out business structures and other issues can and should be taken now, so your privately-owned business is ready for prospective buyers.

We've already seen that privately-owned businesses have a credibility problem in the eyes of the sorts of buyers they are likely to encounter. In this article we'll look at some solutions that can be implemented now to get you ready for a prospective buyer.

Intellectual property

It's not unusual for privately-owned businesses to discover that their logo or other intellectual property isn't actually theirs, but belongs to an employee, contractor or someone else.

This can be a significant headache when you're negotiating a sale, and if unresolved will affect the final sale price.

To fix this problem, owners should review their intellectual property portfolio now. They might need the co-operation of a counterparty who may have no inclination or incentive to assist and may indeed take advantage of the situation, but it is better to solve it now.

Being aware of a problem will also enable a business owner to maximise the chance of resolving it, by picking the best time to seek counterparty cooperation, for example when a contract is being renewed or new work awarded.

They should also review their contracting arrangements to ensure that future intellectual property is clearly theirs.

Litigation

Owners should resolve any outstanding litigation and be prepared to explain how the underlying circumstances that led to the litigation will not recur. It is best to have a year or two between the resolution of any material litigation and a business undergoing buyer due diligence ahead of a sale.

Data room preparation

Loose ends such as unsigned critical contracts should be signed and the inevitable errors (often minor) that might show up in a hastily-assembled data room should be identified and addressed.

Business structure

As we've already noted, business structures can be a problem at sale time. For example, one company runs a number of businesses, but buyers are likely to only be interested in one of the businesses, not the whole package. Practically speaking, the only way to sell is by a business sale. In certain situations selling in that way could present a serious problem.

An example is a strata management business which in essence comprises a large number of separate management contracts with the relevant bodies corporate. All of these need to be assigned to the buyer. Under the strata title legislation, each assignment requires the relevant body corporate to convene a general meeting to provide consent. A buyer would only be prepared to pay for the management contracts which are actually transferred. The seller is at the mercy of all those body corporate general meetings – not a great place to be!

A solution is to prepare the business for sale over time by transferring each separate management contract to a subsidiary that only undertakes that business. This could be done as the AGM for each body corporate rolls around. Then, once all the management contracts have been transferred to the subsidiary, the business is readily saleablebecause all that is required is a sale of the shares in the new subsidiary.

Employees

A lack of proper and well documented systems for employee issues is common amongst privately owned business and will raise buyers' perception of a business' risk.

How a privately owned business presents on this front can be readily addressed through some simple steps – review template contracts and create or update employee procedure manuals and policies for current business risks (OH&S, competition from departing employees, preservation of confidential information, etc.) and changes in legislation. If contracts for current employees need to be varied, then often it makes sense to do so at annual review time, when pay increases or other incentives can improve the likelihood of acceptance.

Value loss after the sale contract

The issues raised so far have largely been about loss of value before a sale contract is signed (a reduced "headline" sale price) arising when possible buyers consider the business presents inappropriate levels of risk. Businesses also risk losing value after the sale contract is signed.

A data room and business that present well build confidence, which will mean that:

  • owners are likely be able to negotiate a reduced post-completion retention. The more risky the business appears, the longer the period of the retention a buyer will seek, and also the greater the proportion of the purchase price; 
  • the claim period in the sale agreement can be reduced;
  • the buyer's perception of risk will be reduced, so value will be protected or better able to be defended; and
  • finally, the risk of errors or omissions will be reduced, and thus the direct risk of a claim for breach of warranty or a claim for misleading or deceptive conduct under the Australian Consumer Law.

As with issues before the sale contract, risk after the sale contract is best addressed with a plan and a process to follow through on the plan.

Conclusion

A business that is poorly prepared for sale can mean the loss of significant value. Often, that value can be readily preserved, if private business owners identify the issues, have a plan to address these and some time to implement their plan. Overall, preparation equals value.

There is one final matter that privately-owned businesses should consider getting right long before a prospective buyer appears – corporate governance. In the next edition we'll look at some ways they can get this right.

 

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Disclaimer

Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this communication. Persons listed may not be admitted in all States and Territories.